Trade, Economic Vulnerability, Resilience and the Implications of Climate Change in Small Island and Littoral Developing Economies

Transcription

1 June 2010 ICTSD Programme on Competitiveness and Sustainable Development ICTSD Series on Trade-Supported Strategies for Sustainable Development Trade, Economic Vulnerability, Resilience and the Implications of Climate Change in Small Island and Littoral Developing Economies By Robert Read, Department of Economics, Management School, Lancaster University Issue Paper No. 12

2 June 2010 l ICTSD Programme on Competitiveness and Sustainable Development Trade, Economic Vulnerability, Resilience and the Implications of Climate Change in Small Island and Littoral Developing Economies By Robert Read Department of Economics, Management School, Lancaster University Issue Paper No. 12

3 ii R. Read - Trade, Economic Vulnerability, Resilience and the Implications of Climate Change in Small Island and Littoral Developing Economies Published by International Centre for Trade and Sustainable Development (ICTSD) International Environment House 2 7 Chemin de Balexert, 1219 Geneva, Switzerland Tel: Fax: ictsd@ictsd.org Internet: Chief Executive: Programmes Director: Senior Programme Officer: Junior Programme Officer: Ricardo Meléndez-Ortiz Christophe Bellmann Ingrid Jegou Paolo Ghisu Acknowledgments ICTSD is grateful for the generous support of the Department for International Development (DFID) of the United Kingdom, the Directorate-General for Development Cooperation (DGIS), Ministry of Foreign Affairs of the Netherlands and the Swedish International Development Cooperation Agency (SIDA). The author is grateful to Gloria Carrión, Paolo Ghisu and Ingrid Jegou of ICTSD for their support as well as positive and constructive feedback on earlier drafts and queries and also to three anonymous referees for their thorough comments. For more information about ICTSD s Programme on Competitiveness and Sustainable Development, visit our website at ICTSD welcomes feedback and comments on this document. These can be forwarded to Paolo Ghisu, pghisu@ictsd.ch and Ingrid Jegou, ijegou@ictsd.ch. Citation: Read, Robert (2010). Trade, Economic Vulnerability, Resilience and the Implications of Climate Change on Small Island and Littoral Developing Economies, ICTSD Programme on Competitiveness and Sustainable Development, Issue Paper No. 12, International Centre for Trade and Sustainable Development, Geneva, Switzerland. Copyright ICTSD, Readers are encouraged to quote and reproduce this material for educational, non-profit purposes, provided the source is acknowledged. This work is licensed under the Creative Commons Attribution-Noncommercial-No-Derivative Works 3.0 License. To view a copy of this license, visit or send a letter to Creative Commons, 171 Second Street, Suite 300, San Francisco, California, 94105, USA. The views expressed in this publication are those of the author and do not necessarily reflect the views of ICTSD or the funding institutions. ISSN

4 ICTSD Programme on Competitiveness and Sustainable Development iii TABLE OF CONTENT ABBREVIATIONS AND ACRONYMS LIST OF TABLES AND BOXES FOREWORD EXECUTIVE SUMMARY v vi vii ix INTRODUCTION 1 1. Introduction to Small Island and Littoral Developing Economies Small Island and Littoral Developing Economies Likely Implications of Climate Change Key Economic Characteristics Key Determinants of Economic Growth The Economic Vulnerability Resilience 7 2. Sources of Economic Vulnerability and Growth Volatility in Small Island and Littoral Developing Economies Openness to International Trade and Economic Growth Openness to International Trade and Economic and Vulnerability Sources of Structural Trade Instability, Economic Vulnerability and Growth Volatility Macroeconomic Implications of Earnings Instability Key Elements in Building Economic Resilience in Small Island and Littoral Developing Economies Enhancing Technological Capacity and Linkage Creation in Small Island and Littoral Developing Economies Enhancing Technological Capacity Enhancing the Creation of Linkage and Spillover Effects A Strategy for Human and Social Capital Formation in Small Island and Littoral Developing Economies Contributing to Human Capital Formation Fostering and Strengthening Social Capital Institutional Innovations 22

5 iv R. Read - Trade, Economic Vulnerability, Resilience and the Implications of Climate Change in Small Island and Littoral Developing Economies 6. Environmental Considerations in Enhancing Competitiveness and Sustainability in Small Island and Littoral Developing Economies Compliance with Environmental Standards Natural Resource Use Biodiversity Environmental Considerations and Sustainability: Implications in the Context of Climate Change Promoting the Reduction of Inequality and Poverty in Small Island and Littoral Developing Economies Macroeconomic Guidelines Competitiveness and Development in Productive Sectors Interactions Between Human Capital and Social Capital Inequality and Poverty Reduction. Implications in the Context of Climate Change Building Resilience for Sustainable Development in Small Island and Littoral Developing Economies in the Context of Climate Change: Policy Recommendations: Enhancing Indigenous Technological Capacity in the Context of Climate Change Human and Social Capital Formation in the Context of Climate Change Environmental Sustainability in the Context of Climate Change Inequality and Poverty Reduction in the Context of Climate Change Conclusion 32 REFERENCES 33

6 ICTSD Programme on Competitiveness and Sustainable Development v ABBREVIATIONS AND ACRONYMS ACP EEZ FDI GDP GNP IPRs MEA PPMs African, Caribbean and Pacific (Group of States) Economic Exclusion Zone Foreign direct investment Gross domestic product Gross national product Intellectual property rights Multilateral environmental agreement Process and production methods RandD Research and development REER Real effective exchange rate REPAs Regional Economic Partnership Agreements SIDS Small island developing states SILDEs Small island and littoral developing economies SMEs Small- and medium-sized enterprises

7 vi R. Read - Trade, Economic Vulnerability, Resilience and the Implications of Climate Change in Small Island and Littoral Developing Economies LIST OF TABLES AND BOXES Table 1 Box 1 Box 2 Small Island and Littoral Developing Economies The Trade Multiplier and the Growth Effects of Trade Shocks in Small Economies Governance of Natural Resource Conservation: Tuna Policies in Fiji and Samoa

8 ICTSD Programme on Competitiveness and Sustainable Development vii FOREWORD While climate change is a global concern, its impacts are expected to cause extraordinary hardship in developing countries, especially those that rely heavily on sectors that are highly exposed to climatic impacts. Among developing countries, small island and littoral developing economies (SILDEs) are very susceptible to the physical impacts of climate change because of their size, proneness to natural hazards and generally low adaptive capacity, while the costs of adaptation relative to the Gross Domestic Product (GDP) are high. Moreover, climate change is expected to have critical implications for the sustainability of SILDEs economic and social wellbeing, since it will likely alter their comparative advantage and trade flows. The loss of trade and growth opportunities is expected to be particularly acute in the agricultural, fisheries and tourism sectors, which are often their main economic activities. Such countries macro-economic characteristics - thin markets, lack of diversification in production, high degree of economic openness, excessive dependence on a narrow range of exports and on strategic imports - also make SILDEs highly vulnerable to external economic shocks. This is why fluctuation of commodity and energy prices and international fluctuations of interest rates can contribute to high growth volatility. Furthermore, SILDEs often face the challenges of a rapidly growing population, susceptibility to natural disasters, lack of economies of scale, remoteness, high transportation and communication costs, and costly public administration and infrastructure. This economic vulnerability affects growth, sustainable development and poverty reduction in SILDEs. It is thus crucial that they build their economic resilience to cope with external shocks and adapt to the impacts of climate change. To do so, they need to take actions to improve their competitiveness and enhance their supply-side capacities, while at the same time addressing environmental and social goals. Indeed, this may create a system of complementarities and linkages between economic sectors; it may also stimulate the diversification of production and exports, strengthening the resilience of their economies. The present Issue Paper (No. 12) on Trade, Economic Vulnerability, Resilience and the Implications of Climate Change in Small Island and Littoral Developing Economies by Robert Read, Senior Lecurer at the Department of Economics at Lancaster University, provides an overview of the challenges confronting SILDEs in building their resilience to economic vulnerability and achieving sustainable development in the context of climate change. It also provides policy recommendations to guide SILDEs in enhancing economic resilience. The author argues that SILDEs appear relatively better prepared to cope with the challenges of climate change than many larger developing countries. Nevertheless, they still face a number of critical challenges, particularly in the context of the structural and policy constraints imposed by their economic characteristics and capacity for resilience. The paper concludes that building that resilience to growth volatility and external shocks, including the impact of climate change, requires appropriate trade policies alongside measures to stabilise earnings and strategic import dependence. It is also crucial to develop the capacities of SILDEs to diversify production, enhance productivity and add value to exports. This requires indigenous capacities to innovate and develop new technologies; it also requires the absorption of adaptation and mitigation technologies. With this paper, ICTSD aims to contribute to a knowledge-based debate in this area and foster greater coordination between trade and climate change issues, particularly as they affect the least and most vulnerable developing countries.

9 viii R. Read - Trade, Economic Vulnerability, Resilience and the Implications of Climate Change in Small Island and Littoral Developing Economies Together with the author and all who assisted him with the paper, I trust that this work will not only be of interest but, most importantly, I very much hope it will contribute to effective and constructive solutions for international trade and climate change negotiations and beyond. Enjoy the reading and please do provide us with feedback, Ricardo Meléndez-Ortiz Chief Executive, ICTSD

10 ICTSD Programme on Competitiveness and Sustainable Development ix EXECUTIVE SUMMARY Small island and small littoral developing economies are especially vulnerable to the effects of climate change because of their size, proneness to natural hazards and generally low adaptive capacity, while the costs of adaptation relative to GDP are high. These climate change effects include rising sea levels, stronger and more frequent tropical cyclones and sea surges, rising sea surface temperatures and increasing acidification of surface waters. The consequences are likely to include increasing inundation of low-lying coastal areas, higher rates of coastal erosion, growing contamination of fresh water aquifers and lenses and irreversible ecological damage to coral reefs, coastal mangroves and fisheries. All of these effects can be expected to have severe consequences for those countries with large littoral or coastal ecosystems relative to their total land area in particular, small island and littoral developing economies (SILDEs). This paper focuses specifically on SILDEs because they are particularly vulnerable to similar effects of climate change on a similar range of economic activities, notably inshore and offshore fisheries and tourism. The paper identifies 45 small developing economies that can be classified as either SILDEs, all of which are vulnerable to similar effects of climate change. Forty-one of these countries have populations of less than 3.5 million; the remaining four have larger populations but are still classified as small island developing states (SIDS). A further 28 non-sovereign territories vulnerable to similar climate change effects could also be classified as SILDEs but are not considered explicitly in the paper. The socio-economic characteristics of SILDEs their high exposure to both the positive and negative effects of globalisation mean that climate change has critical implications for the long-term sustainability of their economic and social well-being. Climate change is expected to have a major impact on all developing countries through its effects on comparative advantage and therefore trade flows. The very strong participation of most SILDEs in international trade means that these effects may be considerable. The loss of trade and growth opportunities is expected to be particularly acute in the agricultural, fisheries and tourism sectors. Sources of Economic Vulnerability and Growth Volatility in Small Island and Littoral Developing Economies Openness to trade is a key factor in economic growth in SILDEs and also a prime source of their resilience. Their heavy reliance upon international trade means that even small trade shocks have a large impact, leading to high growth volatility. Reducing their trade dependence might appear desirable but is likely to severely inhibit their long-run growth and resilience. Improving the trade performance of SILDEs is therefore the most effective policy to enhance their growth and resilience. The principal source of growth volatility in SILDEs is the instability of export earnings as a result of export concentration. Diversification to alleviate earnings instability and growth volatility, however, is severely constrained by diseconomies of scale. SILDEs also have a high exposure to demand shocks in key export markets and dependence upon strategic imports. High instability has important macroeconomic implications; it lowers long-run growth and investment and raises unemployment. Appropriate prescriptive policies are therefore needed in SILDEs to manage economic vulnerability and build resilience capacity. Building Economic Resilience in Small Island and Littoral Developing Economies Good governance is a key element of policy-making and building capacity for economic resilience and is dependent upon the availability of human and social capital. Building resilience capacity in SILDEs fits with growth-enhancing governance, which focuses on enabling effective catching-up by developing countries.

11 x R. Read - Trade, Economic Vulnerability, Resilience and the Implications of Climate Change in Small Island and Littoral Developing Economies Economic Policy SILDEs need to develop their capabilities to diversify production, enhance productivity and add value to exports. This requires indigenous capacity to innovate and adapt technology. Building resilience to climate change also requires the absorption of adaptation and mitigation technologies. The pattern of specialisation in SILDEs suggests that they require only a narrow range of climate change-related technologies, while diversification requires investment in climate-proofed infrastructure and human capital. Domestic RandD in SILDEs is constrained by diseconomies as well as a lack of critical mass of capital and knowledge. The absorptive capacity of labour is key to assimilating adaptation and mitigation climate change technology. Most SILDEs rely upon external sources for technology, e.g. foreign direct investment (FDI). FDI embodies advanced technologies, know-how and market access, all of which are scarce in SILDEs. Creating Spillovers and Linkages Linkages and spillover effects, direct and indirect, improve international competitiveness by raising domestic employment, technological intensity and labour productivity. They also improve co-ordination and integration between sectors by encouraging local supply chains. The economic structures of SILDEs are relatively narrow and shallow, limiting local linkage creation and spillover effects. These effects are further inhibited by shortages of skilled labour that limit the benefits of technology transfer. Human and Social Capital Formation in Small Island and Littoral Developing Economies Human capital formation and augmentation through education and training enhances the domestic stock of human capital and has critical implications for comparative advantage, competitiveness and growth in SILDEs. Arguably, they possess greater social capital, so facilitating greater social enhancement and poverty alleviation would build their resilience capacity. Environmental Sustainability in Small Island and Littoral Developing Economies More stringent environmental standards as a result of climate change are likely to require costly investment in adaptation and mitigation process and/or production methods by SILDEs, with implications for their competitiveness. Many SILDEs depend upon renewable and non-renewable resources for their income, employment and trade, raising issues concerning the depletion of natural capital, environmental degradation and the preservation of unique bio-diversity assets. SILDEs, however, are likely to be in a relatively strong position to implement improved policies to control degradation and depletion so as to comply with increasingly rigorous environmental standards. Such policies also foster the preservation of unique bio-diversities that are a potential source of their comparative advantage. Inequality and Poverty Reduction Macroeconomic Policy Guidelines Because of their structural openness to trade, SILDEs should be well -placed to reduce inequality and poverty in the context of building resilience capacity and adaptation to climate change. Openness to trade promotes non-regressive adjustment and enhances competitiveness but also heightens exposure to external sources of volatility. Limiting trade in SILDEs, however, is likely to inhibit their future growth and give rise to increasing inequality and poverty. Openness is also important in liberalising trade in

12 ICTSD Programme on Competitiveness and Sustainable Development xi climate-friendly environmental goods and adaptation and mitigation technologies. SILDEs should have easy access to these resources owing to their low trade barriers. Their exports, however, may face discrimination on environmental grounds between like products and those with dual use. Building resilience to growth volatility in SILDEs requires appropriate trade policies alongside measures to stabilise earnings instability and strategic import dependence. The infeasibility of diversification has led many SILDEs to alleviate volatility via fixed exchange rate policies. Their greater social capital and cohesion should mean that strongly regressive policies to deal with earnings and growth volatility are avoided. Interactions Between Human Capital and Social Capital Improving interactions between human and social capital in SILDEs is more problematic. Sustaining domestic competition and promoting local linkages and spillovers are likely to be very difficult because of a weak potential for creating linkages and spillovers coupled with shortages of appropriate skills. Building Resilience for Sustainable Development in Small Island and Littoral Developing Economies in the Context of Climate Change: Principal Policy Recommendations Enhancing Indigenous Technological Capacity in Small Island and Littoral Developing Economies There is a pressing need to diversify production structures in SILDES. SILDEs lack capacity for large-scale RandD and instead must rely upon trade and FDI for new technologies and examples of best practice. SILDEs need appropriate policies to maximise potential trade and FDI linkage and spillover effects. Domestic technological spillovers depend upon the absorptive capacity of indigenous human capital. Human capital is critical for SILDEs but investment is needed to enhance the domestic stock and improve absorptive capacity for the challenges of development and climate change. Human and Social Capital Formation in Small Island and Littoral Developing Economies Human capital formation is vital for sustainable development and building resilience capacity in SILDEs. SILDEs need to ensure that their social capital supports growth-enhancing governance on which to build their resilience. Environmental Sustainability in Small Island and Littoral Developing Economies Investment in climate change-related adaptation and mitigation technology is needed to maintain the international competitiveness of SILDEs and ensure continued access to key export markets. SILDEs need effective policies and governance for sustainable natural resource conservation to limit depletion and environmental degradation. SILDEs need to minimise the environmental implications of increasing value-added in downstream processing by ensuring that energy-intensive and polluting activities embody best practice climate change technologies.

13 xii R. Read - Trade, Economic Vulnerability, Resilience and the Implications of Climate Change in Small Island and Littoral Developing Economies SILDEs need to limit the predation of natural competitive advantages bestowed by their unique biodiversities, which offer niches for future growth. Inequality and Poverty Reduction in Small Island and Littoral Developing Economies in the Context of Climate Change Openness to trade is crucial to building resilience in SILDEs and has progressive effects on income equality and poverty reduction. The social capital endowment in SILDEs can ensure that adjustment and stabilisation policies prioritise income equality and poverty alleviation. SILDEs need to use their social capital to improve domestic linkage creation between the informal and formal sectors.

14 ICTSD Programme on Competitiveness and Sustainable Development 1 Introduction Small island and, to a lesser extent, small littoral developing economies are especially vulnerable to the effects of climate change because of their size, proneness to natural hazards and generally low adaptive capacity, while the costs of adaptation relative to GDP are high (Mimura et al., 2007). These climate change effects include rising sea levels, stronger and more frequent tropical cyclones and sea surges, rising sea surface temperatures and increasing acidification of surface waters. The consequences are likely to include increasing inundation of low-lying coastal areas, higher rates of coastal erosion, growing contamination of fresh water aquifers and lenses and irreversible ecological damage to coral reefs, coastal mangroves and fisheries. All of these effects can be expected to have severe consequences for those countries with large littoral or coastal ecosystems relative to their total land area in particular, small island and littoral developing economies (SILDEs). This paper focuses specifically on SILDEs because they are particularly vulnerable to similar effects of climate change on a similar range of economic activities, notably inshore and offshore fisheries and tourism. The paper identifies some 45 small developing economies that can be classified as SILDEs, all of which are vulnerable to similar effects of climate change. Of these, 41 have populations below 3.5 million; the remaining four are classified as small island developing states (SIDS) in spite of their relatively large size. A further 28 non-sovereign territories vulnerable to similar climate change effects could also be classified as SILDEs but are not considered explicitly in the paper. The socio-economic characteristics of SILDEs their high exposure to both the positive and negative effects of globalisation mean that climate change also has critical implications for the long-term sustainability of their economic and social well-being. Climate change is expected to have a major impact on the economies of all developing countries through its effects on comparative advantage and therefore trade flows. The importance of international trade to most SILDEs means that these effects may be considerable. The loss of trade and growth opportunities is expected to be particularly acute in the agricultural, fisheries and tourism sectors. The economies of SILDEs are generally characterised by thin markets, a lack of diversification in production, excessive dependence upon a narrow range of exports and export markets, a reliance on imports for strategic goods and services including energy and foodstuffs and a lack of domestic competition. Many of these characteristics result directly from the effects of their small size, which gives rise to a wide range of diseconomies of scale. Like many larger developing countries, they too face challenges arising from their demographic profiles with high population growth rates, high dependency ratios, high levels of out-migration and dependence upon overseas remittances and their remoteness leading to high transport, communication and co-ordination costs. SILDEs are especially vulnerable to external economic shocks in a number of different forms: exposure to price fluctuations in their principal exports and strategic imports; changes in the global regulatory environment; natural disasters; and the physical impacts of climate change, including rising sea levels. Because of their size, SILDEs have a greater exposure to such external shocks than larger economies and the impacts of these shocks are also disproportionately large. This means that they are likely to experience greater income instability and growth volatility and therefore greater risk and uncertainty in their long-run growth process. The effects of climate change are likely to be felt most by those in poverty, by developing countries in general and by SILDEs in particular. This is because of the limited capacity of SILDEs to deal with climate variability and extremes. Key economic activities in many SILDEs, such as fisheries and tourism, are among those sectors most susceptible to its impacts. Climate change

15 2 R. Read - Trade, Economic Vulnerability, Resilience and the Implications of Climate Change in Small Island and Littoral Developing Economies therefore threatens to exacerbate existing sources of vulnerability as well as creating new ones that are likely to challenge sustainable socio-economic development in all developing economies and SILDEs in particular (see Mimura et al., 2008). The ability to counteract vulnerability and its consequences relies upon the resilience of SILDEs that is, their resource capacity to recover from and/or adjust to the negative effects of exogenous shocks. A critical issue is that the costs of adaptation and mitigation are likely to constitute a significant proportion of their GDP. Building resilience in SILDEs is dependent upon devising and implementing appropriate policy strategies to reduce their vulnerability and its harmful impacts accompanied by the accumulation of precautionary resources. This requires actions targeted to improve the competitiveness of SILDEs and upgrade their supply-side policies while simultaneously ensuring that social and environmental objectives continue to be met. This action is most urgent in the case of the poorest SILDEs, which lack both sufficient resources and policy capacity to foster improved resilience. The objective of this exploratory paper is to derive prescriptive policy actions for SILDEs in facing the challenges of vulnerability and building resilience capacity so as to stabilise incomes and reduce poverty in the context of climate change. It provides a brief overview of the key economic characteristics of SILDEs (based upon the literature on small economies), the key determinants of their economic growth and a discussion of vulnerability and resilience. This is followed by an extended discussion of economic vulnerability, growth volatility and resilience. Attention then turns to the analysis of the boundaries of trade policy space and the implications for vulnerability and resilience in SILDEs in the context of climate change. This analysis broadly follows the Coralles Leal trade policy space framework (2007), with separate sections covering four key areas of interest: economic policy; human and social capital formation; environmental sustainability; and inequality and poverty reduction. The final section provides policy recommendations for building resilience in SILDEs in the context of climate change.

16 ICTSD Programme on Competitiveness and Sustainable Development 3 1. Introduction to Small Island and Littoral Developing Economies This section provides brief background concerning the reasons for this paper s specific focus on small island and littoral developing economies (SILDEs), their key economic characteristics, their sources of growth and the nature of vulnerability and resilience. 1.1 Small Island and Littoral Developing Economies The precise definition of a small economy has been the subject of debate for several decades. One of the earliest analyses argues that economies with populations ranging between 10 and 15 million are small (Kuznets, 1960) while orthodox economic analysis defines a small open economy as one that is unable to affect its own terms of trade an argument that might reasonably be applied to virtually all economies apart from the very largest. Given that some 60 percent of nation states have populations of less than 10 million and 40 percent less than 3.5 million, the focus of mainstream economics on relatively large economies is hard to explain. The United Nations institutions define small economies as those with populations of less than one million while the Commonwealth uses a threshold of 1.5 million. Armstrong and Read, however authors of several largescale analyses of the growth determinants of small economies use a natural break in the population distribution between three and 3.5 million. The distribution of countries according to their population size, however, is effectively continuous such that any threshold is arbitrary. Nevertheless, it is important to note that the key economic characteristics of SILDEs, identified in section 1.3 below, are also continuous but their effects increase in intensity as size falls. This paper therefore follows Armstrong and Read in adopting a relatively broad definition, since most of the issues under discussion apply, to different extents, to many larger economies as well. The focus of this paper, however, is on the implications of economic vulnerability, resilience and climate change specifically on small island and littoral developing economies (SILDEs). SILDE is a non-standard term used here to encompass the vast majority of all small developing economies that possess a littoral, whether they are islands/archipelagos or simply have an oceanic coastline. This focus is critical in that SILDEs are all particularly vulnerable to similar effects of climate change on a similar range of economic activities, notably inshore and offshore fisheries and tourism. Table 1: Small Island and Littoral Developing Economies Sub-Saharan Africa (13) Cape Verde Djibouti Gambia Mauritania Seychelles South Asia (1) The Maldives Middle East and North Africa (2) Kuwait Comoros Equatorial Guinea Guinea Bissau Namibia West Bank and Gaza Congo Gabon Liberia Sao Tome and Principe

17 4 R. Read - Trade, Economic Vulnerability, Resilience and the Implications of Climate Change in Small Island and Littoral Developing Economies Table 1: Continued Latin America and Caribbean (12) Antigua and Barbuda Grenada Panama St Vincent and Grenadines East Asia and Pacific (13) Brunei Marshall Islands Palau Timor Leste Vanuatu Belize Guyana St Kitts and Nevis Suriname Fiji Micronesia, Fed. States Samoa Tonga Additional states classed as Small Island Developing States (SIDS) (4) Cuba Papua New Guinea Dominican Republic Dominica Jamaica St Lucia Trinidad and Tobago Kiribati Nauru Solomon Islands Tuvalu Haiti Source: Adapted from Armstrong and Read (2002a) Note: The table excludes four land-locked small developing economies Botswana, Bhutan, Lesotho and Swaziland. A total of 45 possible SILDEs are identified in Table 1, of which 41 are sovereign states with populations below 3.5 million. Four others are officially classified as small island developing states (SIDS) although their populations are greater than the 3.5 million threshold; three of the 45 are littoral rather than island states. There are a further 28 non-sovereign territories vulnerable to similar climate change effects that could also be classified as SILDEs but are not considered explicitly in the paper. 1.2 Likely Implications of Climate Change Island and littoral economies have been identified as among the most vulnerable environments to the effects of climate change (Michel and Pandya, 2010). These effects include: rising sea levels; stronger and more frequent tropical cyclones and sea surges; rising sea surface temperatures; and increasing acidification of surface waters Michel and Pandya, 2010). The consequences of climate change are therefore likely to include increasing inundation of lowlying coastal areas, higher rates of coastal erosion, growing contamination of fresh water aquifers and lenses, and irreversible ecological damage to coral reefs, coastal mangroves, and inshore fisheries, and possibly deep water fisheries (Pallewatta, 2010). The Millennium Ecosystem Assessment defines a littoral or coastal ecosystem zone as extending up to 100 kilometres inland or until an elevation of 50-metres is reached together with an outward extent of the 50-metre oceanic contour (World Resources Institute, 2005). This definition makes very explicit the link between the effects of climate change and the high degree of vulnerability of small island and littoral developing economies (SILDEs). Further, although they make very little contribution to global greenhouse gas emissions, SILDEs probably have the least resource capacity to deal with its effects. The economic structures of many SILDEs are also highly susceptible to the effects of climate change because of the critical importance of the fisheries and tourism sectors. The growth of tourism in SILDEs, particularly in those that are more remote, has been dependent upon the expansion of relatively low-cost long-haul air links with the lea-ding industrialised economies. Many SILDEs, however, remain heavily reliant upon maritime transport for their trade links with respect to physical goods.

18 ICTSD Programme on Competitiveness and Sustainable Development Key Economic Characteristics This section identifies the salient economic characteristics of small island and littoral developing economies (SILDEs), with reference to the more general literature on small economies. This provides the basis for a better understanding of their distinct economic structures and the consequent constraints that they face, giving rise to their vulnerability to both economic shocks and the effects of climate change. The economic and social development challenges facing small economies such as SILDEs have only become fully apparent in recent decades. These growth challenges are distinct and arise directly as a consequence of their small size. To varying extents, the impact of diseconomies of scale determines the boundaries of their feasible domestic productive activities, composition of output, trade, economic growth and policy-making. It should be noted, however, that many larger developing economies, also experience a similar lack of critical economic mass owing to their relatively low aggregate GDP. Small Domestic Markets Domestic demand in SILDEs lies below the necessary minimum scale for a wide range of productive activities. This means that the unit costs of supplying many goods and services domestically are relatively high, including administration and infrastructure. It also precludes the emergence of largescale manufacturing dependent upon abundant labour supply, a phenomenon that is often associated with high growth and local RandD in developing countries (Thomas, 1982; Briguglio, 1995). Diseconomies of scale also limit domestic competition by constraining the feasible number of incumbent firms (Kuznets, 1960). This gives rise to a prevalence of natural monopolies and oligopolies and therefore further upward pressure on domestic prices. Domestic Resource Constraints The natural resource base of SILDEs is generally limited, with some notable exceptions, since most occupy small geographic areas with limited and homogeneous natural resource endowments. Some Pacific SILDEs, however, possess substantial marine resources through their control of large Economic Exclusion Zones (EEZs) many times greater than their land areas. Domestic labour supply is also constrained by small populations. In spite of their small labour forces, many poorer SILDEs suffer from relatively high rates of unemployment. Income-enhancing growth therefore depends primarily upon nurturing high-value-added activities that are scale neutral and utilise human capital intensively (Bhaduri, et al., 1982). Surplus labour needs to be absorbed by sectors reliant on relatively low skills, such as tourism (Armstrong and Read, 1995). Long-run growth and development in SILDEs is therefore critically dependent on investment in education and training (Briguglio, 1995; Armstrong et al., 1998). Migration to alleviate labour market problems is a particular feature of many SILDEs. Limited domestic employment opportunities have led to significant out-migration from the smallest and poorest, coupled with relatively large inflows of workers remittances as a consequence. Specialisation and Constrained Diversification in Production and Exports The combined effects of small domestic markets, diseconomies of scale constraints and limited labour supplies mean that the pattern of domestic output in SILDEs is necessarily relatively undiversified. This high degree of specialisation in production, often in niche activities, results in a naturally high degree of concentration in exports and, possibly, export markets. SILDEs are therefore highly exposed to the risk of exogenous trade shocks, export price and earnings instability and growth volatility.

19 6 R. Read - Trade, Economic Vulnerability, Resilience and the Implications of Climate Change in Small Island and Littoral Developing Economies Structural Openness to International Trade and Trade Policy Small size necessitates a high degree of openness to international trade in SILDEs since there is necessarily substantial asymmetry between their patterns of domestic production, which are highly specialised, and domestic consumption, which is highly diversified (Kuznets, 1960). Many essential, as well as nonessential, goods and services must therefore be imported. Further, these imports must be financed by export earnings, such that SILDEs have very limited scope for trade policy interventions. This necessarily heavy reliance upon international trade structural openness provides a strong case for the pursuit exportled growth strategies by SILDEs. The structural openness to trade of SILDEs means that their growth orientation must be in close accord with their underlying comparative advantage. This has important implications for the pattern of sectoral specialisation in SILDEs and they have therefore tended to avoid many of the pitfalls associated with overly protectionist industrialisation strategies in many larger developing economies inefficiency, lack of international competitiveness, unemployment and entrenched anti-trade interests. 1.4 Key Determinants of Economic Growth The sustained growth of many small economies generally provides compelling evidence that, while the challenges that they face are very tangible including vulnerability they are not insuperable barriers to growth and prosperity. A disproportionate number of small economies can be found in the World Bank s Upper Middle and High Income groups (see Table 1, Armstrong and Read, 2006). This is a strong indication that many of them have significantly outperformed many larger developing economies in recent years (Armstrong et al., 1998; Armstrong and Read 2001, 2006). This section overviews the principal reasons for their strong growth performance. Sectoral Determinants of Growth An initial UNCTAD study of the sectoral structure of small island developing states (SIDS) highlights the apparent importance of natural resources and/or services together with remittances (UNCTAD, 1997). Subsequent empirical analyses of the sectoral determinants of growth in small economies generally find that rich natural resource bases and strong service sectors notably financial services and tourism are statistically significant factors (Armstrong and Read, 1995, 2001; Armstrong et al, 1998). The contribution of manufacturing is generally indeterminate, reflecting very wide differences between relatively large small economies such as Jamaica and Mauritius and the rest. Agriculture, however, is generally important only in the poorest small economies and is found to have a significantly negative impact on growth performance. Human Capital and Growth The general inference is that the role of human capital is critically important although it is very hard to evaluate its specific contribution to growth. The sectoral evidence (see above) provides tentative support for this view to the extent that human capital-intensive activities, such as financial services and data -processing, are key sources of growth. Further, many small economies rank highly in the UNDP Human Development Index (HDI), which incorporates a significant education component (Briguglio, 1995). Remoteness and Growth The critical importance of international trade to small economies suggests that their proximity to more dynamic markets is likely to generate beneficial growth effects, including regional linkages. These trade linkages are not easily available to more remote SILDEs, particularly those in the Pacific. Empirical studies, using either World Bank-defined global regions or great circle distances from the major industrialised economies, find that location within a dynamic

20 ICTSD Programme on Competitiveness and Sustainable Development 7 region has a significantly positive effect on growth in small economies generally while remoteness has a significant adverse effect (Armstrong et al, 1998; Armstrong and Read, 2006). These findings support the view that high trade costs for visible goods and services, such as tourism, hinder growth (see also Winters and Martins, 2004). Good Governance and Growth The strong performance of many small economies in the UNDP Human Development Index is often taken as de facto evidence that they enjoy high levels of social capital and social cohesion. This implies some form of direct or indirect relationship between the HDI indicators, good governance and economic growth performance. If this is the case, then SILDEs should exhibit greater resilience as well as greater vulnerability than larger economies in dealing with instability and growth volatility. There is copious anecdotal evidence to support the view that many small economies have been able to formulate and implement opportunistic growth-promoting strategies in spite of significant constraints on their policy autonomy. These strategies include targeting revenueraising by offering favourable personal and corporate tax rates and creating a favourable regulatory environment to attract offshore financial services, among other activities. Many have also shown great ingenuity by engaging in international free-riding and rent-seeking, made possible by their relative international insignificance. Free-riding includes reducing expenditure by relying on the defence umbrellas of larger neighbours, global trade liberalisation and the use of third countries currencies (discussed in section 2.4). Rent-seeking includes regulatory differences (e.g., tax rates), locationspecific niches such as strategic military bases, satellite tracking stations, astronomical observatories, issuing stamps and the internet notably Tuvalu s address.tv and other specialist niches such as the Fijian Army s regular provision of UN peacekeeping forces (see Kakazu, 1995; Baldacchino and Milne, 1999; Armstrong and Read, 2002b). 1.5 The Economic Vulnerability SILDEs experience greater economic vulnerability relative to larger countries because of their greater inherent exposure to exogenous economic, political, strategic, ecological, environmental and meteorological factors (Holmes, 1976; Briguglio, 1995). Vulnerability was originally conceived as a measure of the exposure of SIDS to this broad range of factors but its current focus is primarily the economic causes and effects of vulnerability. The characteristics of SILDEs (section 1.3) are critical determinants of economic vulnerability since they are exposed to a greater incidence of short-run volatility about their long-run growth paths and amplify the magnitude of exogenous shocks. Growth volatility therefore has a disproportionate impact on SILDEs compared with larger developing economies. The growth process in SILDEs therefore embodies a greater degree of risk and uncertainty, such that they can expect to experience lower long-run growth trends because of the greater associated risk premiumsa (Easterly and Kraay, 2000). This implies that attaining high income levels requires greater effort and has a higher domestic resource cost than for larger economies. Small economies therefore face greater challenges in achieving sustained long-run growth than do most larger economies (Briguglio, 1995). 1.6 Resilience Resilience is a recent conceptual development and explains the different resource capacities of countries to respond to and ameliorate the impacts of economic vulnerability. The capacity to build resilience and mobilise resources to offset the effects of exogenous shocks may be beyond the means of many SILDEs (see Briguglio et al., 2004; 2006), so further hampering their long-run growth (UNCTAD, 1988). Exposure to economic vulner-ability and an accompanying lack of resilience-building capacity are likely to be greatest in least developed economies (Easterly and Kraay, 2000; Armstrong and Read, 2002a).

21 8 R. Read - Trade, Economic Vulnerability, Resilience and the Implications of Climate Change in Small Island and Littoral Developing Economies The sustained growth experience of many small economies, however, suggests that the impact of vulnerability in SILDEs is somewhat less than expected and/or that they possess greater resilience capacity to assuage its effects. This could be explained by some combination of their sectoral economic structure, pattern of specialisation and effective endogenous policymaking. If the quality of endogenous policymaking plays a critical role in building resilience to vulnerability, then similar exogenous shocks may give rise to very different effects on the long-run growth and income of individual SILDEs.

22 ICTSD Programme on Competitiveness and Sustainable Development 9 2. Sources of Economic Vulnerability and Growth Volatility in Small Island and Littoral Developing Economies This Ssection provides a more in-depth analysis of the principal sources of economic vulnerability and growth volatility in SILDEs. In so doing, it first discusses the concept of openness to trade, since this appears to be the source of some confusion in analytical and policy circles, and its relationship with economic vulnerability and growth in the context of building resilience. The remainder of the ssection is devoted to discussion of the sources of economic vulnerability and its macroeconomic implications for SILDEs. 2.1 Openness to International Trade and Economic Growth The relationship between openness to international trade, economic vulnerability and growth has given rise to some misunderstanding and confusion. Trade openness is not the cause of economic vulnerability but rather provides the means through which the effects of exogenous shocks are amplified and transmitted to the domestic economy. It is, however, the critical determinant of economic growth in small economies and therefore a prime source of resilience. Openness to trade is often defined simply as the share of international trade (total exports plus imports) in gross domestic/national product (GDP/GNP). This definition, however, embodies two related effects: The extent to which economies are, by necessity, more open given their size and level of development structural openness. The extent to which economies are able to determine their own trade policies, contingent upon their (population) size functional openness. The economic literature regards openness to international trade as being one of several important determinants of economic growth. Large-scale cross-section studies of country growth using global data sets find substantial general empirical support for trade openness having a positive and significant impact on economic growth International trade is critical to the growth of SILDEs because it is the means by which they are able to increase the extent of their market and alleviate some of the constraints imposed by their size. Further, their longrun economic development is primarily dependent upon trade because their small domestic markets have only limited capacity to generate autonomous growth. The extent of the reliance of SLDEs on international trade is demonstrated by their very high trade/gdp ratios, which usually far exceed 100 percent. The magnitude of these ratios has important implications with respect to the impact of external trade shocks and the volatility of domestic growth because the multiplier effects of trade are very large (Ashoff, 1989). Even relatively small changes in trade may therefore generate very large domestic growth effects (see Box 1), hence the concern of economic vulnerability analyses with trade openness.